November's winners face pressing retirement, tax issues

White House

(updated with clarification)

With a too-close-to-call presidential race and congressional races that are expected to maintain a Republican-controlled House and Democrat-led Senate, there are two certainties that incoming officeholders need to address — a $1.1 trillion federal budget deficit and tax reform.

Both will put retirement tax incentives and tax rates for private investment and higher-income taxpayers on the table in the search for federal revenue sources.

“We know employee benefits will be in the cross hairs,” said James Klein, president of the American Benefits Council in Washington. “There is no question in my mind that it will be item No. 1 next year, especially if you want to lower tax rates.”

Regardless of who wins the White House or how many seats in Congress change parties, “retirement policy and employee benefit plans are going to be part of the conversation in the search for revenue,” said Brian H. Graff, CEO and executive director of the American Society of Pension Professionals & Actuaries, Arlington, Va. “The fiscal cliff is not partisan.”

The fiscal cliff will come in January, thanks to a combination of expiring tax rates and automatic spending cuts triggered by the absence of a federal budget plan. Chopping more than $500 billion from the federal deficit in such an abrupt way has economists warning of painful shrinkage of an already anemic U.S. economy, along with higher tax bills for 90% of taxpayers.

Failing to address the federal deficit is not an option: Moody's Investor Service already is promising to downgrade the U.S. AAA credit rating, and there's the prospect of politically unpopular across-the-board spending cuts for most federal programs.

The increasingly desperate hunt for federal revenue is setting the stage for the first major tax code overhaul since 1986, as congressional and White House budget negotiators scrutinize every possible tax expenditure to trim or cut entirely.

Both presidential candidates said they want to lower the tax rates overall. Republican candidate Mitt Romney is proposing to fund the lower rates with fewer tax deductions, including fewer deductions for retirement savings. President Barack Obama is calling for raising tax rates for higher-income earners and capping the retirement contribution exclusion for those taxpayers. Mr. Obama has also proposed ending the carried interest deduction for private equity general partners, who could be forced to pay ordinary income tax rates of up to 35%.

If Mr. Romney is elected and follows through on his plan to eliminate any taxes on capital gains, “that could be the end to many 401(k)s because small-business owners will choose to terminate their plans and get the zero tax on capital gains instead,” said Mr. Graff, who noted that the 1986 tax reform process cut the deductibility of 401(k) contributions by 70%. “Every time they do tax reform, the retirement system comes under attack. We have to be prepared for that.”

More optimistic

John J. Kalamarides, senior vice president for institutional investment solutions with Prudential Retirement, Hartford, Conn., is more optimistic that retirement tax incentives will survive. “I have great confidence that there is an understanding that tax deferrals (for retirement savings) are different,” he said.

If and when the federal budget crisis is resolved, the focus is expected to shift to ways Congress and the executive branch can encourage more retirement savings, including regulations that simplify auto enrollment and auto escalation, and bring more awareness of lifetime retirement income.

“Folks agree more than 50% on what the solutions are,” said Mr. Kalamarides. “The major issues are coverage, are people saving enough, and longevity. The opportunity is ripe for compromise.”

Sen. Tom Harkin, D-Iowa, who chairs the Senate Health, Education, Labor and Pensions Committee, agrees. In July, Mr. Harkin unveiled a proposal for a universal private retirement system with professional money management. He is now working with diverse constituent groups to develop a legislative framework for it.

“Regardless of the outcome of the election, I plan to aggressively push for improvements to the system,” Mr. Harkin said in an e-mailed statement. “I look forward to working with my colleagues on both sides of the aisle as well as those in the private sector to solve the retirement crisis once and for all.”

Rep. John Kline, R-Minn., chairman of the House Education and Workforce Committee, will be looking at “structural challenges” and possible pension reforms, particularly for multiemployer pension plans, where funding rules are set to expire in 2013. His committee, which is focused on boosting employment, will also keep an eye on the Pension Benefit Guaranty Corp. and Department of Labor regulators and will “oppose any effort that drives up costs and denies investment opportunities,” a committee aide said.

While a change in party leadership in the House and Senate is not expected, pension issues would still be on the congressional radar, with Republicans preferring individual incentives for retirement savings and Democrats more likely to include a role for government to encourage defined benefit and defined contribution plans.

With divided control in Congress limiting the prospects of legislative changes, the biggest difference this election could make is on the regulatory front. For the Labor Department, a second Obama term makes it likely there will be a reintroduced fiduciary rule, a proposed rule putting lifetime income projections on plan participant statements, and more fee disclosure activity. Phyllis Borzi, assistant secretary of labor for the Employee Benefits Security Administration, is expected to stay on to shepherd those initiatives.

Pushed aside

If Mr. Romney takes the White House, a controversial proposal to update a 1975 definition of a fiduciary by expanding it to cover more types of investment advisers and situations is expected to be pushed aside in order to deal with issues like electronic disclosure, simplification of new fee disclosure rules and lifetime income statements. “They are issues that are not terribly exciting but that really matter,” said Bradford Campbell, who was deputy and then assistant secretary of labor in charge of the Employee Benefits Security Administration from 2004 to 2009.There is also the reality of a new administration's “steep learning curve,” said Mr. Campbell, now an attorney with Drinker Biddle & Reath LLC in Washington. “It's very hard for a new administration to hit the ground running. If there is a change, you're probably not going to see new policies coming out for a while, but you might see old policies stopped.”

The Securities Exchange Commission could look very different as well: Mr. Obama is intent on finishing regulations completing the Dodd-Frank Wall Street Reform and Consumer Protection Act, while Mr. Romney had pledged to repeal the act entirely. There also would be a learning curve for any new commissioners.

This article originally appeared in the October 29, 2012 print issue as, "November's winners face pressing retirement, tax issues".